Disability cover is vital when you start working

Disability assurance is one of the most problematic areas of life assurance, accounting for most of the complaints submitted to the life assurance ombudsman each year. And many people regard disability assurance as simply an add-on to assurance to cover an early death.

In this last part of our series on risk life assurance, we look at disability assurance, its variations and why it is not simply an add-on life assurance option.

The purpose of life assurance that pays out on death is to ensure that your dependants will be able to maintain their standard of living when you are no longer there to provide for them.

Assurance that covers you in the event of a disabling disease or injury ensures that both you and your dependants will remain financially secure. In other words, it is for your dependants plus one.

No one is immune to accidental injury or serious illness. If you are unable to work for an extended period, you will have financial problems. Disability is not a condition that affects only the elderly; it is the inability to work at any age because of a health or physical problem.

Unless you have dependants, you may not need life assurance against dying. But every working person needs disability assurance, from the day he or she starts to work. After all, you could be disabled on your first day on the job, and, whether or not you have dependants, you will need an income for the rest of your life.

There is a problem with assurance against conditions that prevent you from working: many people simply do not want to work and will invent all sorts of reasons so they can rely on disability assurance instead.

Disability assurance is plagued by fraudulent claims, requiring life assurers to employ medical specialists to ensure that the claimed disability is valid and that it complies with the definition of disability or impairment in your policy.

In an effort to reduce fraud, life assurance companies traditionally tried to limit disability assurance to 75 percent of your income so that the incentive to work would outweigh the desire not to work.

Disability assurance comes in different forms and under different names, including income protection assurance, sickness assurance and impairment assurance.

It is one of the most complex types of assurance because of misunderstandings over the benefits covered, policy definitions and limitations. The choices, limitations and exclusions related to disability and income protection assurance create a legal and technical minefield.

Many disability policies do not come with a commitment to pay you out for the rest of your life, and the amounts that you can expect to be paid may vary dramatically.

It is for these reasons that there are so many complaints to the Ombudsman for Long-term Insurance. Aggrieved policyholders believe they are entitled to a benefit, whereas the life assurance company believes they are still fit enough to work another day, month and year.

Schalk Malan, executive director: product at life assurer BrightRock, says the important issues you need to take into account when buying assurance to cover you and your dependants if you are unable to earn a living are:

* Whether to buy job-based disability assurance and/or medical condition-based impairment assurance;

* Will you be paid out if you have a temporary and/or a permanent disability?

* Will you receive a lump sum payout or regular monthly benefits?

* Will there be a waiting period before you are paid out?

* Will you have to participate in a rehabilitation programme aimed at getting you back to work?

Mind the gap

Very few South Africans have sufficient assurance to ensure that they and their dependants will be able to maintain their standard of living if they are incapacitated by a serious illness or accident. Yet every day at least 144 employed people are left disabled as a result of serious illness or accidental injury.

Independent research undertaken in 2010 by True South Actuaries & Consultants on behalf of the Association for Savings & Investment SA showed that most South Africans will face a substantial reduction in their standard of living if they were unexpectedly unable to earn a living.

The research found that the only income group that does not have a disability gap are those earning less than R3 000 a month because they are covered by state grants for disability.

The average disability under-assurance gap for those earning between R3 000 and R5 800 a month is 58 percent; for those earning between R5 800 and R8 300 the gap is 70 percent; for between R8 300 and R16 700 it is 72 percent; and for over R16 700 it is 60 percent.

You have a choice of two types of cover

There are two main types of disability assurance:

* Traditional disability assurance, which is based on whether or not you are physically able to work; and

* Functional impairment assurance, which pays a lump-sum benefit for a predefined event such as an illness or an accident that limits your ability to carry out physical functions.

Traditional disability assurance is paid based on your ability to work or not. Impairment assurance is based only on functional impairment.

Many financial advisers suggest you have disability cover based on your occupation, as well as a level of functional impairment cover.

Disability assurance

Much of the contention over traditional occupational disability assurance (or job-defined assurance) concerns what is meant by “unable to work”. The definitions differ from policy to policy.

Occupational disability assurance is divided into three options:

* Own occupation. You are paid out if you can no longer perform the job you are currently doing. This option is normally restricted to professionals.

* Own or similar or reasonable occupation. You qualify if you can no longer perform your current job or a similar job that you could reasonably be expected to do, given your ability to perform the required tasks.

With this option, you may have to take on a job that pays less or one that has few promotion opportunities.

The life assurer must be reasonable in deciding whether you must perform a similar job, taking account of your experience, training, employment and personal history.

* Any occupation. You are paid out only if you can do no job at all. If you have this type of cover and are disabled but are still capable of working, you will be forced to take up any job, even a menial one that pays relatively little. However, as with “own or similar” cover, the principle of what is reasonable must apply.

You pay higher premiums for “own occupation” cover than for “similar occupation” cover, and higher premiums for “similar occupation” cover than “any occupation” cover.

Functional impairment insurance

The criteria for the payment of benefits are based on the level of illness or impairment, defined in medical terms. Whether or not you can work is not a deciding factor.

Functional impairment benefits are tiered, taking into account the importance of the part of your body you can no longer use in relation to the rest of your body.

To measure functional impairment, account is taken of your ability to perform daily activities.

A functional impairment policy will pay you a percentage of the amount for which you are insured for a particular condition, depending on its severity. So if you lost an arm inan accident, you would be paid less than if you lost both arms and both legs.

Schalk Malan, executive director: product at life assurer BrightRock, says it is not a matter of choosing between job-defined disability and impairment assurance. You need a combination of both. He says not all impairments will result in an inability to work with a consequent loss of income.

You may be disappointed at the claims stage if you hope an impairment product will meet a potential lost income need.

Impairment products are list-based products, meaning that if a particular impairment suffered is not on the list of impairments in the contract, then you will not be paid.

Another issue to consider is the “matching principle”. Stand-alone impairment products only pay once-off lump sums whereas “income” disability products may pay regular streams of cash or lump sums.

And these lump sums may not be well matched with your need to compensate for a loss of income received regularly over a long period.

You need to match your disability assurance needs to the number of years you will support yourself (and dependants) without a job and your future income needs.

 It pays to have a policy with flexible benefits

If you are permanently disabled, you will probably face a choice in how you want to be paid a benefit.

Schalk Malan, executive director: product at life assurer BrightRock, says there are two main ways disability benefits are paid. These are:

* Income. You are paid out a monthly income. If your disability or income protection scheme is attached to a retirement fund (a group life and disability benefit), the amount will be paid until you become entitled to receive a pension.

* Capital (lump sum). You are paid a lump sum, which you must invest to provide an income.

Malan says both traditional disability and impairment lump-sum and income benefits may be affected by a number of factors. These include:

* Delay before initial payment. In most cases, there is a delay, ranging from a week to a few months, before you are paid the benefit. If you are employed, you need to investigate your paid sick leave entitlement, which may cover the waiting period.

You may need to consider buying a policy that will pay for severe illness on diagnosis without waiting periods that could exceed the remaining days of your life.

* Temporary payment. Payments may be temporary, and the assurance company may require you to undergo rehabilitation to get you back to work.

* Scaled payment. Most policies have various permutations of payment. For example, you are paid 100 percent of your income for the first two or three years, and then 75 percent of your income for all subsequent years.

* Inflation-related payment. Your payments normally increase at a pre-selected rate.

Malan says there is an ongoing debate on whether it is best to select a capital lump sum payout or recurring payout on a permanent disability product.

He emphasises that it is not an either-or debate. There is also a choice offered by some life assurance companies where you can take payment partly as a lump and partly as ongoing income.

Malan says in deciding what options to take you need to ask yourself what the intent is of your disability cover. For example:

* Will the benefit be used to settle a debt if you are disabled? Malan says you don’t want to worry about debt if you suffer a permanent disability, especially if your ability to earn an income is affected.

* Will the benefit be required for lifestyle adaptations such as having your home or motor vehicle altered if you have lost the use of your legs?

* Will the benefit be used to protect your future earnings or expenses following your disability?

Malan says in South Africa most consumers are under-insured (see “Mind the gap”, above). If you are one of the millions of South Africans who cannot afford to insure your full earnings in the event of a permanent disability, a good starting point would be first to look to protect your future expenses (after settling your debts), such as:

* Healthcare expenses (medical scheme contributions and recurring expenses not covered by the scheme);

* Children’s expenses (education costs, as well as their living costs); and

* Other household expenses.

Malan says these recurring expenses can be plotted on a graph illustrating your future needs (see graph).

In calculating your future expenses you also need to take account of inflation. This means you would need to increase the required amount each year by inflation. This is not a single figure. Your medical expenses would generally grow by more than the average inflation rate each year.

The expenses of, for example, your children might require cover only until they are finished with their studies; other expenses might require cover until your death or retirement.

Malan says the decision on whether to select a lump sum or recurring income payment on disability is difficult, with advantages and disadvantages for both.

Lump sum advantages

* A lump sum allows you to invest for an income, settle debt, pay additional medical expenses and even for alterations to your home if physically disabled.

* You can receive a higher income flow in the event of a short life expectancy prognosis because of a terminal disease. This is particularly relevant if you are under-insured in the event of your death.

Lump sum disadvantages

* The lump sum could be badly invested and managed or spent too quickly on things like a new car.

* A lump sum invested to give you income may not be sufficient if you have a longer life expectancy prognosis, particularly if your injury is, say, the loss of a hand, impacting on your ability to work in your current field of expertise or even another field.

* It is typically more difficult to match an income from a capital amount than from a recurring benefit.

Recurring benefit advantages

* Income provision will provide great peace of mind because it removes the risk of your capital running out due to poor investment returns or longevity.

* The premium for recurring income cover is normally cheaper than lump-sum cover because payment is delayed.

Recurring benefit disadvantage

* Could provide you with poor value in the event of early death following the disability.

Malan says you need to consider disability assurance that offers you the best of both capital and recurring benefits for your income needs.

This should include being able to select your disability cover to pay out as a lump sum when you take out the policy but being able to change your mind at the claim stage to convert to a recurring benefit.

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